MOS

Business Context and Reporting Period

Company: The Mosaic Company (Mosaic)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 30, 2006 (Second Quarter of Fiscal 2007)
Business Overview: Mosaic is a leading global producer and marketer of concentrated phosphate and potash crop nutrients. Operations are organized into four segments: Phosphates, Potash, Offshore, and Nitrogen. The company was formed in 2004 through the combination of IMC Global Inc. and the fertilizer businesses of Cargill, Incorporated. As of November 30, 2006, Cargill owned approximately 65.1% of Mosaic's outstanding common stock.

Key Financial Metrics

Note: Total Debt calculated as Short-term debt ($74.9M) + Current maturities of long-term debt ($217.8M) + Long-term debt ($2,208.6M) + Long-term debt due to Cargill ($2.2M).

Material Changes vs. Prior Period

• Revenue: Net sales increased 2% ($24.5M) for the quarter compared to the prior year, driven by higher sales in Phosphates, Potash, and Offshore segments. However, for the six-month period, sales decreased 3% ($90.5M) due to lower volumes.
• Profitability: Gross margin declined significantly to 10.5% from 13.9% in the prior year quarter. Operating earnings dropped 35% to $90.7M. The decline was primarily attributed to lower selling prices for Phosphates and Potash, higher production costs, and unrealized losses on derivatives.
• Segment Performance:
  • Phosphates: Gross margin fell to 4.7% from 9.2% due to lower prices, higher natural gas costs, and idle plant costs from restructuring and an explosion at the Faustina, Louisiana facility.
  • Potash: Gross margin decreased to 25.1% from 36.5% due to lower prices, higher costs, and derivative losses, despite a 5% increase in sales volume.
  • Offshore: Gross margin improved to 4.8% from 3.1%, driven by a recovery in Brazil and higher volumes in India.
• Foreign Currency: The company recorded a foreign currency transaction gain of $19.8M for the quarter, compared to a loss of $13.7M in the prior year, largely due to the weakening Canadian dollar.
• Tax Rate: The effective tax rate decreased to 31.9% from 48.9%, primarily due to a reduction in the Canadian corporate tax rate.

Guidance, Outlook, Risks, and Unusual Items

• Refinancing (Subsequent Event): On December 1, 2006, Mosaic completed a major refinancing. It purchased approximately $1.4 billion of outstanding senior notes and debentures and refinanced a $345 million term loan. This was funded by issuing $950 million in new senior notes and new term loans. The company expects this to lower annual cash interest by approximately $29 million.
• Operational Disruptions:
  • Esterhazy Brine Inflow: A new brine inflow was identified at the Esterhazy, Saskatchewan potash mines. Estimated mitigation costs for fiscal 2007 range from $20 million to $40 million. While storage capacity exists for several months, there is a risk that costs could increase materially or require changes to mining processes.
  • Faustina Explosion: An explosion at the Faustina, Louisiana ammonia plant on October 11, 2006, caused the plant to be idle for repairs until mid-January 2007, reducing phosphate production rates.
• Legal and Environmental Contingencies:
  • EPA RCRA Initiative: The EPA has targeted phosphate facilities for review under the Resource Conservation and Recovery Act. Mosaic has received Notices of Violation (NOVs) at four Florida facilities and is in discussions with the DOJ and EPA. Potential costs include capital modifications and civil penalties.
  • Florida Water Balances: New state rules require more stringent process water management. Compliance may require additional measures with potential material effects on financial condition.
  • Fosfertil Merger: Mosaic filed a lawsuit in Brazil to prevent a proposed merger involving Fosfertil (in which Mosaic holds a 19.8% interest), challenging the valuation and corporate actions. An injunction was obtained pending adjudication.
• Internal Controls: The company disclosed that its disclosure controls and procedures were not effective as of November 30, 2006. This was due to material weaknesses in internal controls (Phosphates monitoring, segregation of duties, tax accounting) and implementation issues with a new enterprise resource planning (ERP) system. These issues caused a delay in filing this 10-Q report.

Investor Verification Checklist

• Debt Covenants: Verify compliance with financial covenants (leverage and interest coverage ratios) under the new credit agreement following the December 2006 refinancing.
• ERP Implementation: Monitor the stabilization of the new enterprise resource planning system and the remediation of identified material weaknesses in internal controls.
• Esterhazy Mine Status: Track the volume of the new brine inflow at Esterhazy and the actual costs incurred for mitigation versus the $20-$40 million estimate.
• Regulatory Outcomes: Assess the resolution of EPA RCRA investigations and the potential financial impact of consent orders or penalties in Florida and Louisiana.
• Product Pricing: Monitor trends in phosphate and potash selling prices, which have been under pressure, and the impact of the announced price increases for North American potash customers.